Bonds are simply a legal ‘IOU’ where an investor (lender) loans money to a Government or Firm (issuer) in exchange for a predetermined interest rate of return, known as the coupon rate. When the bond matures, assuming no default from the issuer, the principal is returned to the lender.

The coupon rate is the percentage of a bond’s principal which is paid to lender on a pre-defined frequency, usually semi-annually.

Depending on the quality of the bond issuer, bonds can provide diversification to investment portfolios because of their typically low/negative correlation to equities, stable income, capital preservation and their potential to remain liquid during crisis.

Inflation erodes the purchasing power of a bond’s future cash flows. Higher inflation may lead to higher interest rates from central banks which can reduce the price of existing bonds.

Government bonds are considered “risk-free” because they’re backed by the full faith and credit of the issuing government. This means the government guarantees to repay the bond’s principal and coupons, making default highly unlikely. That said, not all nations are necessarily stable, making issuer selection a critical consideration.

Duration represents a weighted-average of the cash-flows over the life of a bond. Measured in years, it gives the investor an idea of the time over which the yield will play out. It can also provide a sense of a bond’s estimated sensitivity to a standard ±1% change in interest rates. For each year of duration, a percentage increase in rates will reduce a bond’s price by a percent.

Bond prices and interest rates tend to move in opposite directions. So, when interest rates rise, a bond’s price tends to fall (and vice versa). If , for example, you held a bond that pays a 4% interest rate, and rates rise, that original 4% may no longer look as attractive when compared to other market offerings.